The Pricing Newsletter

This issue ushers in the second year of the pricing newsletter... and there's still so much more to discuss.

Join us as we continue the good fight helping companies earn higher profits, strategically dominate the competition, and better understand the needs of the marketplace.

Pricing Question from a Reader

Today's question comes from reader J. T.

My company offers a service to people in a small geographic area. A close rival recently raised its prices and seems to be doing well. Does that mean that I should raise my prices too?

Your question is a lot more complex than it first appears. Let's break it down, and examine what you're really asking.

Did Your Competitor Really Raise Its Rates?

First, let's uncover some of the assumptions that are buried in your question.

Are you sure that your competitor actually raised its prices? Many firms do whatever they can to look more successful and desirable than they are. For instance, owners of apartment buildings are notorious for providing stealth discounts to renters and hiding their true vacancy rates. This allows the apartment buildings' agents to really soak the occasional high roller who forgets to perform thorough research before signing a contract. It also allows them to demand better terms from investors looking to park their money.

It is probably worth looking into the matter further. Here are a few questions that, if answered, might help you determine whether your competitor's prices are really as high as they seem:

Has your competitor grandfathered the bulk of its current customers? The firm may only be staying afloat because of income from existing clients who are paying lower rates.

Has your competitor included additional credits in its pricing packages? For instance, do customers who commit to a year's worth of service receive one or two months of service for free?

Has your competitor implemented discounting or couponing programs that decrease the actual prices that are paid by consumers? If your competitor has raised prices by 20% but provides 20% off coupons, it has actually reduced its pricing.

Has your competitor simply added expensive offerings that no one has actually purchased?

Is your competitor funding operations with debt? Many companies can survive for months or even years because of large investments or prior income - even if no income is being earned.

Has Your Competitor Benefited from Price Increases?

Assuming that your competitor has actually raised its pricing, it's important to determine if the firm is better off for it. Sure, the company might be earning more per sale, but it might also be bleeding out the bulk of its customers left and right. A little bit of research could provide some very enlightening evidence.

How easy is it to set up an appointment?

Are the firm's facilities and equipment being maintained?

Is the firm's parking lot emptier than it used to be?

Are you and other competitors acquiring increasing numbers of your rival's former customers?

Some firms simply raise prices out of desperation. It's possible that your competitor's costs have spiraled out of control, and the firm has fallen into the all too common trap of believing that the only way to deal with the situation is to raise prices. If your competitor's price increase is the result of desperation, it may serve to hasten your competitor's march toward bankruptcy. Should this be the case, it may make sense simply to wait until the firm goes bust before making any changes to your pricing. At that point, the marketing landscape will be further in your favor due to a reduction in the number of your competitors.

What Are the Long-Term Ramifications of the Price Increase?

Even if all signs are positive at present, and the firm's profits have increased, your competitor may be open for a rude awakening. Many businesses experience revenue as a lagging indicator of customer satisfaction. A good number of your competitor's existing customers might be actively looking for a new supplier, but have not yet had the opportunity to make the switch. In addition, many of the new customers that the firm has signed up may find themselves dissatisfied with the level of service they receive in exchange for their dollars. A bit of sleuthing may reveal some hidden truths - and the potential for you to acquire some additional customers.

Is Your Competitor's Business Similar to Your Business?

If you're still confident that your competitor's successes are real and will stand the test of time, you'll want to consider whether your business and your competitor's business are similar enough for its experiences to prove relevant.

Are your competitor's goals the same as yours? It may be that you're focused on maximizing profits, while your competitor is trying to goose its average customer value in order to sell the firm to investors at the highest possible price. Alternatively, your competitor may be looking to move toward 5-star service, while you're completely content to offer 2-star service. Reconfiguring your offering to better support higher prices might necessitate trade-offs that you're either unwilling or unable to make.

Are you viewed as being similar to your competitor? In other words, is your DUMB evaluation in the same ballpark as your competitor's? The Four Seasons and McDonalds both serve coffee, but I'm willing to bet that one of them is able to charge quite a bit more than the other.

How Strong Are Your Financials?

If you're certain that your firm is equivalent to your competitor's, you can finally start thinking about what makes strategic sense.

When businesses have traditionally considered their pricing power, they've always looked to the customer: How much will a shopper willingly pay for a vendor's offering?

While helpful, this line of thinking contains two glaring omissions: vendor liquidity and risk tolerance. Firms with significant levels of retained earnings can wait for the perfect time to sell their wares and the perfect customer to buy them. They can make investments in rebranding, messaging, and re-engineering to better equip themselves to sell their offerings at higher rates. They can also weather the storm caused by some portion of their customer bases leaving for less expensive vendors.

The question is: Can your firm do the same? Does your firm have the liquidity required to say "no" to the next handful of customers who walk in your door?

What about First-Mover Advantage?

As I often point out, your business is just one facet of the marketplace. You also need to consider your environment. Your competitor may have faced a very different landscape when it decided to raise its prices. Depending upon the size and makeup of your local market, it may have been able to gobble up the bulk of potential customers willing to pay high prices. Should this be the case, it will not simply be enough to attain value parity with your competitor. You'll have to find some means to convince your competitor's customers that there is a compelling reason to go through the hassle (to incur the switching costs) of leaving their current providers and hiring you instead. Don't forget that movement away from existing suppliers represents a potential risk for customers. You need to offer an incentive to make their effort worthwhile.

Optimists may argue that my concerns demonstrate that I'm coming from a scarcity mindset, which is probably true; after all, economics is fundamentally concerned with the scarcity of resources. In any case, it is certainly something to consider, given the potentially small size of your market.

In addition, some economists, myself included, believe that the country is due for an economic correction in short order. Even if your competitor is performing well now, it may not in the future. Should its buyers feel financially stressed, the firm's high prices may become its Achilles heel as customers are forced to seek out less expensive alternatives in order to deal with reduced budgets.

Conclusion

It may make sense, assuming that your competitor has given up on its existing client base, to attempt to focus your efforts on the types of customers that it is no longer interested in servicing. This will allow your firm to expand. Your competitor might even be willing to refer clients with smaller budgets, both existing and prospective, to you just to get them out of its hair. In essence, there's a chance that you could create an additional supply of leads at no cost to yourself. Remember, all things being equal, the larger your existing customer base, the more risk you can take on when expanding into higher-priced offerings.

One way to test your marketplace's willingness to accept higher prices is to consider adding a few upsells to your pitches. Ask customers if they would be willing to pay for additional or higher-end services. This approach is far less risky than a direct increase in pricing and would provide you with valuable information about your clients' willingness to part with larger sums of money. The worst that could happen is that everyone will say "no." I can't imagine that any customers would find a gentle upsell to be sufficient cause for taking their business elsewhere.

Unfortunately, a single competitor's pricing decisions are often insufficient evidence upon which to build a pricing strategy. There are far too many assumptions that must be made and far too many risks that may be accepted.

Not only are most pricing decisions based upon gut feelings, haphazard research, and a dubious approach to analysis, but their effects are often difficult to spot without an eye for hidden detail.

An informed decision would require more insight into your competitor's results, the nature of your market, the particulars of your firm's offerings, and, of course, your appetite for, and willingness to accept, risk.

Questions come from readers like you.
If you'd like your questions answered, send them my way.

From the Blog Archives

Notable Pricing Quote

"I felt exactly how you would feel if you were getting ready to launch and knew you were sitting on top of 2 million parts - all built by the lowest bidder on a government contract." -- John Glenn (astronaut)